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Unformatted text preview: n annuity of $1 table . . .
Find the 10period row, move
across until you find the factor
5.216. Look at the top of the column
and you find a rate of 14%.
14%
Periods
1
2
...
9
10
Managerial Accounting 10%
0.909
1.736
...
5.759
6.145 12%
0.893
1.690
...
5.328
5.650 14%
0.877
1.647
...
4.946
5.216 1327 Internal Rate of Return Method: An Example Decker Company can purchase a new machine at a
cost of $104,320 that will save $20,000 per year in
cash operating costs.
The machine has a 10year life. The internal rate of return on
this project is 14%.
If the internal rate of return is equal to
or greater than the company’s required
rate of return, the project is acceptable.
Managerial Accounting 1328 Net Present Value vs. Internal Rate of Return
y NPV
y is easier to use. Less of an advantage now with the availability
Less
of IRR functions in spreadsheets such as
Excel.
Excel. y Questionable
y Managerial Accounting assumption with IRR: Internal rate of return method assumes cash
Internal
inflows are reinvested at the internal rate of
return. 1329 Expanding the Net Present Value Method To compare competing investment projects we
To compare competing investment projects we
can use the following net present value
can use the following net present value
approaches:
approaches: Totalcost Incremental cost Managerial Accounting 1330 The TotalCost Approach White Company has two alternatives:
White Company has two alternatives:
(1) remodel an old car wash or,
(1) remodel an old car wash or,
(2) remove it and install a new one.
(2) remove it and install a new one.
The company uses a discount rate of 10%.
The company uses a discount rate of 10%. New Car
W ash
Annual revenues
$ 90,000
Annual cash operating costs
30,000
Net annual cash inflows
$ 60,000 Managerial Accounting Old Car
W ash
$ 70,000
25,000
$ 45,000 1331 The TotalCost Approach
If White installs a new washer . . .
Cost
Productive life
Salvage value
Replace brushes at
the end of 6 years
Salvage of old equip. $300,000
10 years
7,000
50,000
40,000 Let’s look at the present value
of this alternative.
Managerial Accounting 1332 The TotalCost Approach
Install the New Washer
Cash
Year
Flows
Initial investment
Now
$ (300,000)
Replace brushes
6
(50,000)
Net annual cash inflows
110
60,000
Salvage of old equipment
Now
40,000
Salvage of new equipment
10
7,000
Net present value 10%
Factor
1.000
0.564
6.145
1.000
0.386 If we install the new washer, the
investment will yield a positive net
present value of $83,202.
Managerial Accounting Present
Value
$ (300,000)
(28,200)
368,700
40,000
2,702
$
83,202 1333 The TotalCost Approach
If White remodels the existing washer . . .
Remodel costs
Replace brushes at
the end of 6 years $175,000
80,000 Let’s look at the present value
of this second alternative.
Managerial Accounting 1334 The TotalCost Approach
Remodel the Old Washer
Cash
10%
Year
Flows
Factor
Initial investment
Now
$ (175,000)
1.000
Replace brushes
6
(80,000)
0.564
Net annual cash inflows
110
45,00...
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 Spring '09
 R.DUCHARME

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